Impact of fiscal deficit on the economy

Fiscal deficit is the difference between the government’s total expenditure (both the current and capital) and total revenue receipts of the government. Borrowings by the government is not included while calculating the total revenue receipts. Fiscal deficit occurs either due to deficit in revenues or increase in capital expenditure.  Most of the times, governments fund the fiscal deficit either through borrowings from the central bank or by raising money from capital markets through issuance of various bonds and treasury bills (Tchaidze 2007).

Role of fiscal deficit in the economics of a country

There has not been any unique view regarding the role played by fiscal deficit in any economy. On the one hand the Keynesian view supports that large fiscal expenditure by the government through deficit financing will improve the economic condition of any country (Lee 2012). On the other hand the Ricardian approach argues that it doesn’t make difference as consumers cut expenditure in anticipation of higher tax, which the government will pose on the consumers to pay the borrowings. Similarly the neo-classical economist argues that the increase in the government expenditure negatively affect the saving and hence affects growth (Nickel & Vansteenkiste 2008).

Comparative review of developing and developed countries

Increasing fiscal deficit is one of the major problems faced by the growing economies. As already discussed in the previous section that there is no unique view on whether the deficit run by the government is good for the country or not. In case of the developing countries a study by Terrones & Catão (2005) shows the relationship between fiscal deficit and inflation in developing countries and there has not been any significant relation in advanced countries.

Fiscal deficit in developed countries
Fiscal deficit in developed countries (as a percentage of GDP) (Source: Compiled by author from various IMF reports)

As seen in the above graph most of the developed countries are in deficit and United States had fiscal deficit of more than 12 percent of its GDP during 2009. One reason for this huge deficit can be due to the global financial crisis which started in US in 2008. Other developed countries are also in deficit except for South Korea which has seen both the deficit and surplus during 2008-2015.

Fiscal deficit in developing countries
Fiscal deficit in developing countries (as a percentage of GDP) (Source: Compiled by author from various IMF reports)

In terms of fiscal deficit the developing countries also have similar trend as developed countries however most of the developing countries has taken measures to reduce the fiscal deficit. As shown in the figure the fiscal deficit of India in 2008 was around 10 percent of total GDP which has reduced to less than 7 percent in 2014. Only the Russian Federation was enjoying surplus except for 2009. However the total surplus a percentage of GDP has declined over time.

Reasons for fiscal deficit

The main reasons for increase in fiscal deficit is either decreased revenue collection or increase in government expenditure. The major expenditure of both the developing and developed countries has shown below with some comparative analysis.

Health: The global share of the developing countries (BRICS) in the total health expenditure is increasing. Since 1995 the total share in global health expenditure of these countries increased from 4 % to 12% of their total expenditures. Among the developing nations Brazil is the leading country in health expenditure, currently 9.31 % of its GDP, whereas the total health expenditure by India is 4 % of its GDP. In case of the developed countries the global share in healthcare expenditure by developed countries (OECD) is still higher than the BRICS countries. However the ratio of the health expenditure which is measured by OECD/BRICS fell from 22 times in 1995 to 7 times in 2012. This shows that the health expenditure by the developed countries is declining whereas the expenditure by the developing countries is increasing.

Defense: Defense is one of the leading sectors where the government spending is the most. According to Frost & Sullivan the total expenditure on defense by BRICS countries was 21.4 percent of the global defense expenditure in 2014 as compare to 13 percent in 2008.  Among the developed countries US has the highest defense expenditure which comprises of 34 percent of the global defense expenditure in 2014 which is 3.5 percent of the US Gross Domestic Product (GDP). However the defence expenditure by US has been declining over the time period as a percent of GDP.

Share of world military expenditure by developing countries (2014)
Share of world military expenditure by developing countries (2014) (Compiled by author from World Bank Data Base)
Share of world military expenditure by developed countries
Share of world military expenditure by developed countries (2014) (Compiled by author from World Bank Data Base)

Subsidies: Subsidies are the benefits provided by the government to individuals or groups of individual in the form of cash or through tax reduction. Subsidies are usually given either to promote a certain industry or to protect the welfare of the people in the industry. With an increase in the provision of subsidies the expenditure of the government increase which is one of the contributor to the deficit in the budget. Subsidies in the developed countries like US and UK has declined over the period of time and it has remained same for some countries like South Korea. In case of the BRICS countries there is a mix trend. Countries like India and Brazil have reduced subsidies as a percent of the GDP, while in Russia and China it has increased. China is further expected to increase the subsidy in various sectors to boost the economy after the slowdown in the economy in the recent times.

Impact of fiscal deficit

There has not been any conclusion about whether the fiscal deficit is good or bad for any economy; some economists argued that it is essential for the economic growth of a country because only domestic savings is not enough for investment. And others argue that a huge deficit may lead to an increase in the tax rate and decrease in savings. However it can be concluded that some amount of fiscal deficit is good for economic growth as long as the borrowed money is used for productive purposes and the rate of return from that investment is higher than the interest rate paid.

References

  • Lee, D.R., 2012. The Keynesian Path to Fiscal Irresponsibility. Cato Journal, 32.
  • Nickel, C. & Vansteenkiste, I., 2008. Fiscal policies, the current account and Ricardian equivalence, Frankfurt am Main.
  • Tchaidze, R., 2007. Quasi-Fiscal Deficit in Nonfinancial Enterprises, New York.
  • Terrones, M.E. & Catão, L.A.V., 2005. Fiscal deficits and inflation. Journal of Monetary Economics., 52.
Indra Giri
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